GAO IJnited States General Accounting Of’fice

Report to the Chairman, Subcommittee on Federal Services. Post Office. and

I I I

N. .1N . C;ivil Service, C;ommittee on Governmental Affairs, U.S. Senate

August, 1 XX3 ARMY MATERIEL COMMAND

(;AO/NSIAI)-!333-233:3

Providing Early Retirement Incentives in 1990 Could Have Saved Money I

GAO United States General Accounting Office Washington, D.C. 20548

National Security and International Affairs Division

B-253975

August 24,1993

The Honorable David Pryor Chairman, Subcommittee on Federal Services,

Post Office, and Civil Service Committee on Governmental Affairs United States Senate

Dear Mr. Chairman:

In our report entitled Army Materiel Command: Factors Influencing Retirement Decisions During 1990 Reduction in Force (GAO/NSIAD-93-28BR,

Dec. 31,1992), we advised you of Army Materiel Command (AMC) employees’ responses to 10 hypothetical voluntary early retirement incentives and the increased rate at which the employees might have retired under each incentive. Subsequently, you asked that we estimate the change in government costs that would have resulted from implementing each of the incentives. This letter provides those estimates and also estimates the impact that each of the incentives would have had on offsetting involuntary separations at ANZ had it pursued its initial lo-percent 1990 force reduction goal.

Background AMC directs the development, test and evaluation, procurement, distribution, maintenance, and disposal of nearly all Army equipment. In 1990, AMC had about 104,000 employees, of whom 59,000 were at locations subject to reductions in force (RIF). In response to anticipated budget cuts, AMC planned to reduce and demote its work force by about 10 percent and 13 percent, respectively, by mid-October 1990. To limit the number of workers who would have to be involuntarily separated, AMC obtained U.S. Office of Personnel Management (OPM) approval to allow early retirements,

In our 1992 report, we pointed out that early retirements helped reduce the number of involuntary separations but they could not have prevented a large number of additional involuntary separations. About 11 percent of the AMC work force was eligible to retire early,’ and a small proportion (2 percent) chose to do so.

“‘Early retirement” is retirement with 25 years of total federal service at any age or with 20 years of federal service at age 50 or older. “Standard retirement” is retirement at age 55 with 30 or more years of federal service, at age 60 with 20 years of service, or at age 62 with 5 years of service.

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For our 1992 report, we sent a questionnaire to AMC employees who were eligible for early or standard retirement during the 1990 RIF but elected to continue to work. We asked them to assess the probability of their retiring if any of 10 hypothetical incentives to retire had been available. The incentives included various cash payments, annuity increases, and combinations of both. Depending on the incentive, between 6 percent and 75 percent of the retirement-eligible employees said that they would have retired.

Results in Brief As might be expected, the incentives that were more financially attractive to the employees generally lowered the potential savings to the government. However, the key determinant of whether early retirement causes the government to incur added costs or achieve substantial savings is the extent to which employees are replaced. If a retiring employee is not replaced, the government realizes a savings from the difference between the employee’s salary (net of retirement deductions) and the retirement annuity. If the employee is replaced, the savings are offset by the new employee’s salary and fringe benefits costs. Because AMC was in a period of budget reduction and employee downsizing, we would reasonably expect that only a minimum number of the employees who opt for voluntary early retirement would be replaced.

If AMC did not replace the voluntary early retirees, we estimate that the net present value life cycle savings-the net reduction in government expenditures-from additional retirements stimulated by the incentives could range from about $100,000 to nearly $205,000 per retiree. (See app. I for each alternative incentive’s savings if retiring employees were not replaced and for the costs if they were.)

The four incentives that involve up-front cash payments would require net increases in first-year cash expenditures, but we estimate that this outlay would be offset by savings in the second and/or third year after retirement. The impact of the net increase in first-year cash expenditures could also be mitigated by paying cash incentives in installments. Deferred payments could, however, impact on the number of persons who would have chosen the option.’ Appendix II identifies how major factors-salary, annuity, and

20ur December 1992 report indicates that the prospective elimination of an up-front cash payment (alternative anmdty option/lump sum) would have reduced the number of nonincentive early retirees by about 46 percent. We believe the prospect of having received the cash payment on a deferred basis-d potentially mitigating the income tax consequences-could have enhanced its attractiveness.

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cash bonuses-affect the savings or costs of the 10 hypothetical early retirement incentives.

Our analysis indicates that the use of some incentives could have provided a means to achieve a substantial increase in the number of voluntary separations and save money, thus reducing the need to resort to involuntary separations under AMC’S 1990 planned lo-percent reduction in force. As shown in appendix III, AMC could not have avoided all involuntary separations through the use of retirement incentives. However, on the basis of the employees’ responses to our questionnaire, we estimate that prospective involuntary separations could have been reduced by about 24 percent to 73 percent, depending upon the incentives used to increase voluntary early retirements.

The study population in our 1992 report also included 2,456 employees who were eligible for normal retirement. Many of these people also indicated that they would haven chosen to retire under one or more of the hypothetical incentives. On the basis of historical OPM retirement data, the incentives could have induced retirements from 112 year to 5 or more years earlier than they would otherwise occur. As with the population of employees eligible for early retirement, savings would occur to the extent that foregone salaries and annuities exceed the size of incentive payments. Under the higher cost incentives, savings for this group could be smaller than those for the early retirement group if those who accepted the incentives were heavily weighted toward employees who would have retired within a year or two without them. The development of costs or savings for this population, however, was beyond the scope of this study.

Scope and Methodology

Our savings and cost estimates are based on a stratified variable probability sample of 5,463 employees who were eligible for early retirement during AMC’S 1990 RIF and were stationed at 21 locations throughout the United States. The savings estimates are conservative because salary savings only include the period from the early retirement until about 91 percent of the population would have normally retired. The methodology we used was reviewed by officials of the Congressional Budget Office and OPM’S Office of the Actuary. They generally concurred with the overall methodology we used to generate our estimates, and their suggested refinements were incorporated where appropriate.

The questionnaires were administered in July 1991. The answers to the questionnaires represent the respondents’ recollections of their attitudes,

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perceptions, and circumstances at the time of the 1990 RIF. The passage of about a year’s time between the 1990 RIF and the questionnaire may have distorted some recollections.

The costs or savings for early incentive retirements were determined by comparing the difference between the salaries (less 7 percent for the employees’ contribution toward retirement) that would be avoided from the time employees took early retirement until the time they would likely have taken normal retirement,3 minus bonus payments, and plus or minus the difference in life cycle annuity payments the employees would have received for retiring at an earlier and later date. We determined the key cost elements used in this study through a review of ongoing and prior Department of Defense cost studies and discussions with officials from OPM’S Office of the Actuary and the Congressional Budget Office.

Using a formula derived from historical retirement rates obtained from OPM, we projected varying retirement rates for successive years based on the average age of the group, until about 91 percent of the population would have retired. The average age, years of service, and salary used to compute annuity values were based on information obtained from AMC’S data on employees eligible for early retirement. OPM also provided us with its estimated age/gender-based annuity payout tables from which the total life cycle values of the annuities were estimated. All 1990 dollars were inflated at a 5-percent rate and discounted at a 7-percent rate, which is consistent with OPM projection methodology.

The estimated number of early retirement eligible employees who would opt for an incentivized early retirement was determined using the face value assumption method in conjunction with responses to the early retirement incentive questions in our questionnaire. That is, those responding they would have “definitely,” “probably,” “about 50/50,” “probably not,” and “definitely not” retired were assumed to have retired at the following percentage rates, respectively: 100, 75, 50,25, and 0. A “don’t know” response was also considered to be a O-percent retirement rate. We also assumed that all those who took early retirement without an incentive would have retired under each of the retirement options.

3We are aware that in similar analyses, OPM calculates savings using the employee’s salary net of both retirement and Medicare deductions. Our analysis assumes that most early retirees will find nonfederal employment elsewhere and wili continue to pay Medicare tax as well as social security taxes on the new salaries. To the extent retiring employees do not find other jobs, consistency would require that we take into account lost income tax revenue as well as the aforementioned taxes.

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With respect to replacement employees, we assumed that their aggregate salaries would be the same as those of the incentive early retirees. This is a conservative assumption. Most plausible replacement scenarios would yield some level of cost savings since it is likely that controls on aggregate payroll or employee ceilings would accompany the authority to use early retirement incentives. We did not, however, compute the additional pension trust fund liability that would result from adding new replacement employees l/2 to 8 years earlier.

Our review was performed from January to July 1993 in accordance with generally accepted government auditing standards. Our report was informally discussed with officials of OPM, AMC, and the Congressional Budget Office. Their suggestions have been incorporated as appropriate.

We are sending copies of this report to other involved congressional committees, the Director of the Congressional Budget Office, the Secretaries of Defense and the Army, and the Directors of the Office of Management and Budget and OPM. We will also make copies available to others upon request.

Please contact me at (202) 512-5140 if you or your staff have any questions concerning this letter. Major contributors to this report are William E. Beusse, Assistant Director, and Robert T. Bontempo, Evaluator-in-Charge.

Sincerely yours,

Mark E. Gebicke Director, Military Operations and Capabilities Issues

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Appendix I

Potential Government Savings or Costs Under Hypothetical Early Retirement Incentives Considered in GAO’s 1992 Study

Net savings if retiree were not Net costs if retiree were Projected incentive replaced replaced

retirements Per retiree Total Per retiree Total 2,119 $101,350 $214,760,052 $110,314 $233,755,964 Give a 1 -year salary bonus and

increase the annuitv bv 10 aercent

Add 5 years of service to the annuity 1,761 100,173 176,404,473 111,491 196,335,831 computation Give a l-year salary bonus 1,572 146,819 230,945,814 64,845 102,001,658

Reimburse employee for unused sick leave

1,488 179,777 267,508,390 31,887 47,447,642

Grant a tax-free rollover of employee pension contributions to an individual retirement account

Base annuity on highest l-year salary Waive to 5 of under-age-55 up years annuitv oenaltv Give l/2-year salary bonus

Grant more time to plan for retirement

1,347 204,768 275,822,496 6,896 9,288,912

1,258 182,178 229,180,016 29,486 37,093,296 1,162 178,613 207,548,044 33,05 I 38,405,524

1,013 169,956 172,165,259 41,708 42,250,373

788 204,768 161,357,184 6,896 5,434,048

Reduce under-age- 55 annuity penalty 703 187,752 131,989,839 23,912 16,809,953 to 1 percent

Note: Savings are shown in 1990 net present value dollars and represent the difference between salary and annuity from the time the incentive retirement was taken until about 91 percent of the employees are estimated to have taken their normal retirement. While the potential savings per individual are based on factual knowledge of the retiree population, it should be noted that the projected numbers of incentive retirements are based on the opinions of survey respondents and may not necessarily represent what they actually would have done.

Page 6 GAO/NSIAD-93-233 Retirement Incentives

Appendix I Potential Government Savings or Costs Under Hypothetical Early Retirement Incentives Considered in GAO’s 1992 Study

GAO/NSIAD-93-233 Retirement Incentives

Atmendix II

Major Factors Contributing to Savings or Costs Under Selected Hypothetical Early Retirement Incentives

Factors

Give l-year salary bonus and increase the Add 5 years of service to annuity annuity by 10 percent computation

Per Per individual Population Total individual Population Total

With no retiree replacement Savings:

Salary

costs: $211,664 2,119 $448,518,016 $211,664 1,761 $372,740,304

increased pension payout to

-nonincentive retirees

-incentive retirees

35,710 902 32,210,420 70,776 902 63,839,952

42,606 2,119 90,282.114 75,239 1,761 132,495,879 Bonus or sick leave Davments to

-nonincentive retirees 36,830 902 33,220,660 0 0 0

--tncentive retirees 36,830 2,119 78,042,770 0 0 0 Subtotal costs 233.755.984 198.335.831

Net incentive savings

With retiree replacement

$101,350 2,119 $214,760,052 $100,173 1,761 $176,404,473

Savings:

Salary costs:

$0 0 $0 $0 0 $0

Increased pension Davout to

-nonincentive retirees -incentive retirees

35,710 902 32,210,420 70,776 902 63,839,952 42,606 2,119 90,282,114 75,239 1,761 132,495,879

Bonus or sick leave payments to

-nonincentive retirees 36,830 902 33,220,660 0 0 0 -incentive retirees 36,830 2,119 78,042,770 0 0 0 Subtotal costs 233,755,964 196,335,831

Net incentive costs $110,314 2,119 $233,755,984 $111,491 1,761 $196,335,831

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Appendix II Major Factors Contributing to Savings or Costs Under Selected Hypothetical Early Retirement Incentives

Grant a tax free rollover of employee Reimburse employee for unused sick pension contributions to an individual

Give a 1 -year salary bonus leave retirement account

Per Per Per individual Population Total individual Population Total individual Population Total

$211,664 1,573 $332,947,472 $211,664 1,488 $314,956,032 $211,864 1,347 $285,111,408

0 902 0 0 902 0 0 902 0

6,896 1,573 10,847,408 2,309 1,488 3,435,792 6,896 1,347 9,288,912

36.830 902 33.220.660 18.415 902 16.610,330 0 0 0

36,830 1,573 57,933,590 18,415 1,488 27,401,520 0 0 0

102,001,658 47,447,642 9,288,912

$148,819 1,573 $230,945,814 $179,777 1,488 $267,508,390 $204,768 1,347 $275,822,496

$0 0 $0 $0 0 $0 $0 0 $0

0 902 0 0 902 0 0 902 0

6.896 1.573 10.847.408 2.309 1.488 3.435.792 6.896 1.347 9.288.912

36,830 902 33,220,660 18,415 902 16,610,330 0 0 0

36,830 1,573 57,933,590 18,415 1,488 27,401,520 0 0 0

102,001,858 47,447,642 9,288,912

$64,845 1,573 $102,001,658 $31,887 1,488 $47,447,642 $6,896 1,347 $9,288,912

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Appendix II Major Factors Contributing to Savings or Costs Under Selected Hypothetical Early Retirement Incentives

Factors

Base annuity on highest l-year salary Per

individual Population Total

Waive up to 5 years of under-age-55 annuity penalty

Per individual Population Total

With no retiree replacement Savings:

Salary costs:

$211,664 1,258 $266,273,312 $211,664 1,162 $245,953,568

Increased pension Davout to -nonincentive retirees 13.287 902 11.984.874 14.886 902 13.427.172 -incentive retirees 19,959 1,258 25,108,422 21,496 1,162 24,978,352

Bonus or sick leave payments to

-nonincentIve retirees 0 0 0 0 0 0 -incentive retirees 0 0 0 0 0 0 Subtotal costs 37,093,296 38,405,524

Net incentive savings $182,178 1,258 $229,180,018 $178,613 1,162 $207,548,044

With retiree replacement

Savings:

Salary costs:

Increased pension payout to

-nonincentive retirees

-incentive retirees Bonus or sick leave payments to

-nonincentive retirees -incentive retirees

Subtotal costs

$0 0 $0 $0 0 $0

13,287 902 11,984,874 14,886 902 13,427,172

19,959 1,258 25,108,422 21,496 1,162 24,978,352

0 0 0 0 0 0 0 0 0 0 0 0

37,093,296 38,405,524 Net incentive costs $29.486 1,258 $37.093.296 $33,051 1.162 $38.405.524

Page 10 GAO/NSIAD-93-233 Retirement Incentives

Appendix II Major Factors Contributing to Savings or Costs Under Selected Hypothetical Early Retirement Incentives

Reduce under-age-55 annuity penalty to Give a l/2-year salary bonus Grant more time to plan for retirement 1 percent

Per Per Per individual Population Total individual Population Total individual Population Total

$211,664 1,013 $214,415,632 $211,664 788 $166,791,232 $211,664 703 $148,799,792

0 0 0 0 0 0 7,453 902 6,722,606

6,896 1,013 6,985,648 6.896 788 5,434,048 14,349 703 10,087,347

18.415 902 16.610.330 0 0 0 0 0 0

18,415 1,013 18,654,395 42,250,373 5,434,048 16,809,953

$169,956 1,013 $172,165,259 $204,768 788 $161,357,184 $187,752 703 $131,989,839

$0 0 $0 $0 0 $0 $0 0 $0

0 0 0 0 0 0 7,453 902 6,722,606

6,896 1,013 63985,648 6,896 788 5,434,048 14,349 703 10,087,347

18,415 902 16,610,330 0 0 0 0 0 0

18,415 1,013 18.654,395 0 0 0 0 0 0

42,250,373 5,434,048 16,809,953

$41,708 1,013 $42,250,373 $6,896 788 $5,434,048 $23,912 703 $16,809,953

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Appendix III

Estimated Impact of Hypothetical Early Retirement Incentives on Involuntary Separations

(703026) Page 12 GAO/NSIAD-93-233 Retirement Incentives

Involuntary separations

Incentive

Reduce under-age-55 annuity oenaltv to 1 oercent Grant more time to plan for retirement

Without With Reduction’ incentive incentive Number Percentb

3,192 2,420 772 24

3,192 2,327 865 27

Give l/2-year salary bonus 3,192 2,080 1,112 35 Waive to 5 of up years under-age-55 annuity penalty Base annuity on highest l-year salary

Grant a tax-free rollover of employee pension contributions to an individual retirement account

3,192 1,016 1,276 40

3,192 1,811 1,381 43

3,192 1,713 1,479 46

Reimburse employee for unused sick leave

3,192 1,559 1,633 51

Give a l-year salary bonus Add 5 years of service to the annuitv comoutation Give a 1 -year salary bonus and increase annuity by 10 percent

3,192 1,465 1,727 54 3,192 1,259 1,933 61

3,192 866 2,326 73

aThere were 3,192 jobs that had to be abolished through a combination of normal voluntary early retirements, incentive-induced voluntary early retirements, and involuntary separations. The reduction figures represent the number of involuntary separations that might have been avoided had these incentives been available.

bThe percentages represent the reductton in involuntary separations that could have been made relative to the 3,192 abolished jobs.

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